Consumer Price Index: Headline inflation moderates to 4 per cent but core inflation rises to two-year high

Inflation moderated in May as the effects of the Federal Government’s fuel tax relief artificially reduced consumer prices, but an August rate hike is still regarded as a danger after a key underlying measure of inflation soared to a two-year high.

The consumer price index dropped to 4 per cent in May, down an annual pace of 4.2 per cent in April.

While it’s good news, headline inflation has now been above the Reserve Bank’s 2-3 per cent target for the 10th-straight month, meaning another interest rate rise is still possible at the RBA’s next meeting in August, in seven weeks’ time.

Underlying inflation, without the volatile price items, actually rose to two-year high of 3.6 per cent, up from 3.4 per cent, as the expiring 32-cent-a-litre reduction in fuel taxes artificially reduced headline but not core inflation.

“Unfortunately today’s data adds to the case for a rate hike. There’s two numbers we look at - the most critical being core inflation and frustratingly we are seeing this rise which will give the RBA the justification it needs to increase rates, most likely in August,” KPMG chief economist Brendan Rynne said.

Fuel prices last month rose by an annual pace of 7.7 per cent, down from 18.6 per cent in April, which brought down the CPI but not trimmed mean inflation, the Reserve Bank’s preferred measure that better reflects actual price increases.

“When it comes to the trimmed mean - the measure of underlying inflation - we’ve made it clear for some time, that the costs and consequences of the war in the Middle East will be felt for some time,” Treasurer Jim Chalmers told reporters in Canberra on Wednesday.

“The Government’s efforts to cut the fuel excise are part of the story but not the whole story, even when it comes to this very welcome moderation in fuel costs, reflected in the inflation figures today.”

The existing 32-cent a litre relief expires on June 30 and is being temporarily replaced by 16-cent a litre tax cut until August 2, as the US and Iran work out a peace deal.

“That extension of the fuel excise relief in a tapered way provides cost of living help,” Dr Chalmers said.

“It recognises that there’s still some uncertainty in the Middle East and that the costs and consequences of that war will play out for some time.”

The latest Australian Bureau of Statistics data is a sign of more pain to come for home borrowers and consumers, with Westpac still seeing rate rises in August and September, even with crude oil prices now easing to three-month low level of $US75 a barrel.

“Even with oil prices off their highs, and other commodity prices easing to a lesser extent, we expect further pass-through from still elevated fuel and commodity costs over coming months,” economists Neha Sharma and Sian Fenner said.

“This is likely to keep inflation uncomfortably high for the RBA which will be concerned that high inflation is becoming embedded in domestic wage and price setting behaviour.”

The reduction in fuel prices since petrol and diesel tax relief came into effect in April saw goods inflation fall to an annual pace of 4.2 per cent in May, down from 4.7 per cent.

A 6.9 per cent annual fall in holiday travel and accommodation costs, following Easter and the school holidays, is another price measure that reduces headline but not underlying inflation.

But services inflation increased by 3.7 per cent, up from 3.5 per cent, with education costs climbing by 4.8 per cent over the year.

The Reserve Bank’s February, March and May rate rises caused housing costs to rise by 6.5 per cent over the year, with this figure reflecting increase in mortgage repayments and rents.

New dwelling costs rose by 5.6 per cent over the year, in a sign elevated construction costs will hamper Government efforts to boost supply.

The 30-day interbank futures market sees the RBA leaving rates on hold in August but raising them in November to a 15-year high of 4.6 per cent.

“For households, the message is familiar but uncomfortable. Inflation is no longer surging, but it is still eroding purchasing power. Until price growth slows more convincingly, cost-of-living pressure will remain real, and the risk of another rate hike will remain firmly on the table,” Deloitte Access Economics partner Stephen Smith said.

The 4 per cent increase in headline inflation was better than market forecasts of 4.3 per cent but the trimmed mean increase of 3.6 per cent was slightly higher than market predictions of 3.5 per cent.